03 Nov Social Risk: The Disruptive Edge for Investment Professionals
Measuring returns is relatively simple, but quantifying the risk of an asset is an art that requires specialized analysis. Social risk analysis measures threats that emanate from societies in the form of protests, strikes, violence, and litigation. It offers investment professionals an opportunity to reduce variance and increase consistency across diverse business and geographic environments. When investors incorporate social risk analysis into their operations they can (1) identify mispriced assets to optimize long-term, risk-adjusted returns, (2) safeguard investments from social risk’s extreme negative skew, and (3) attract new investors who prioritize a “socially responsible” platform or protection from reputational damage.
In today’s risk-adjusted investment world, investment managers continually attempt to better define and evaluate an asset’s risk profile. Extra risk should result in a higher potential upside, yet traditional risk analysis often fails to quantify an investment’s true level of risk. This is especially prevalent in frontier markets where civil unrest, uprisings, and other social conflicts can result in an extreme downside scenario. As investment professionals enter new geographies and markets they need a better mechanism to measure and compare risks to maximize returns.
ENODO Global’s Social Alignment Cubed (SA³) operating platform delivers customized social risk analysis to provide investment professionals a competitive edge. The platform, originally designed for U.S. Special Operations Forces to pinpoint the underlying causes of instability, has been refined for the private sector. It uses a proprietary population-centric methodology that leverages data collection tools and a network of experts to forecast the impacts of social risk on an acquisition target, business sector, or geographic region. In addition to providing specialized risk analysis that reduces volatility and safeguards investors’ reputations, it delivers unique advantages for:
• Plan Sponsors / Investors: To consistently and comparatively rank assets based on exposure to all risks influenced by social risk
• Index Providers and Passive Managers: To create and re-weight indices for socially conscious investors
• Active Managers: To quantify social risk analysis into the investment decision, identify mispriced targets, and implement mitigation strategies to maximize risk-adjusted returns
• Sell-side Firms: To update screens with buy, hold, or sell recommendations for a firm or region
ENODO’s Social Risk Rating for Investment Professionals
The impact of social risk on returns is a combination of two factors: (1) environment and (2) actors within that environment. ENODO assists investment professionals to quantify and integrate social risk analysis into their existing due diligence process or financial model. Alternatively, environment and actor scores are combined to provide a standalone rating from 1-9 that delivers buy, hold, and sell recommendations for asset based on social risk. This rating system allows clients to compare social risk levels across their portfolio as well as serve as a baseline for ENODO to develop and implement engagement strategies to mitigate current and future risks.
• High Risk (Sell): A 7-9 score warns of an imminent or ongoing social risk that can negatively impact an investment that the asset’s management does not have an effective strategy to mitigate.
• Medium Risk (Hold): A 4-6 score signifies that an investment is not in imminent danger of loss as a result of social risk, however, a change in the management’s mitigation strategy or the environment can shift the rating up or down.
• Low Risk (Buy): A 1-3 score indicates that a firm is operating in an environment with few social risks and/or has an effective risk mitigation strategy in place.
Index Providers: Attract Socially Conscious Capital
Over $6 trillion of today’s investments are considered socially responsible due to the nature of the targets’ business model. Index providers have attempted to bundle a representative sample of this asset class in order to provide diversification or exposure for existing or prospective clients. New Environmental Social and Governance (ESG) indices are meant to replace the original socially conscious investment practice of avoiding companies that sell addictive substances (alcohol, gambling, or tobacco) or use unsustainable resources (oil, gas, or coal). Yet, ESG indices remain one-dimensional and rely on checklists to determine if a company has socially conscious business practices.
Superior returns relative to peers will continue to attract investors to indices claiming exposure to socially conscious firms. ENODO’s social risk analysis provides a multi-faceted approach that quantifies and compares a firm’s social impact where it operates. Index providers can package and continuously track highly ranked firms to differentiate from checklist-based indices and re-weight existing indices based on social risk analysis to increase risk-adjusted returns.
Active Investment Professionals: Leverage New Risk Analysis
ENODO’s social risk analysis delivers active managers unique insights that improve investment decisions. First, ENODO’s Initial Investigations enrich market screens by identifying the social risks currently affecting a sector or geographic area – these enhance traditional operational, geopolitical, technical, and country risk assessments. Second, ENODO’s Quick Look Reports reveal critical social risks in an operating environment and forecasts potential threats that may impact returns. Third, ENODO’s adaptive population-centric methodology produces Situation Reports that forecast future stability or instability, which drive valuations.
ENODO’s analysis provides quantifiable and comparable insights into volatility for active managers to overweight or underweight assets to beat their benchmark. Regardless of whether the investment is buying a fraction of the equity in a public company, or a controlling stake in a private company, ENODO collaborates with management to mitigate social risk and limit extreme financial loss. Additionally, the platform provides forecasts to decide when to strategically exit a company, sector, or geography.
Case Study: Goldman’s $200 million Social Risk Loss
Goldman Sachs Sells Colombian Coal Mines to Murray Energy: Goldman Sachs invested $600 million in Colombia Natural Resources, which included two mines, a coal port facility, a railroad stake, 11 locomotives, and 530 rail-cars. Goldman sold the above assets and more than 184 million tons of coal reserves for $10 million due to the impacts of social risk.
Environment Score (6): The nexus of threats between Colombia’s local indigenous populations, environmental groups, non-government organizations, political activists and criminal networks presents significant challenges for multinational corporations. Compounding these threats are coordinated asymmetric attacks and pressures on multinational extractive companies and other highly visible foreign investors from local, national, regional and international entities.
Actor Score (6): Goldman relied on the Colombian government to manage its social risk. The national government, especially in rural areas, has little authority or capacity. As protesters created a human blockade in front of the mine, Goldman did not have a sufficient risk mitigation plan in place and was forced to rely on the government, which refused to provide assistance.
Combined Score (8): The environment and actor scores combined to create an operating environment ripe for manifestations of social risk. This dynamic situation forced Goldman to hedge their exposure through other internal business lines and accept a $200 million loss.
Goldman’s extreme financial loss could have been mitigated at a fraction of the cost, if it had leveraged ENODO’s SA3 Operating Platform. The platform offers exclusive, proactive social risk analysis to enable clients to re-classify traditional risks and enhance risk-adjusted returns. ENODO’s Social Risk Rating allows clients to compare risk profiles across firms, sectors, or geographies. In addition, the analysis forecasts activities so clients can mitigate the drivers of volatility before they occur. In today’s dynamic business environments where social tensions can quickly escalate to unrest or violence, ENODO’s capabilities safeguard reputation and increase profits.